Revealed Preference is a fundamental concept in consumer theory within the field of economics. Developed by economist Paul Samuelson, it states that the preferences of consumers can be revealed by their purchasing habits, given their income and the prices of goods remain constant.
The Theory Explained
The Basic Concept
Revealed Preference theory posits that if a consumer chooses a particular combination of goods over another, given their budget constraints, this choice reveals their preference. For example, if a consumer buys apples instead of oranges, we can infer that they prefer apples as long as the prices and their income remain unchanged.
Mathematical Representation
In mathematical terms, let \( x = (x_1, x_2, …, x_n) \) and \( y = (y_1, y_2, …, y_n) \) represent two different bundles of goods. If the bundle \( x \) is chosen over bundle \( y \) when both are affordable within the consumer’s budget constraint, then \( x \) is revealed preferred to \( y \).
Types of Revealed Preference
Weak Axiom of Revealed Preference (WARP)
The Weak Axiom of Revealed Preference states that if a consumer chooses bundle \( x \) over bundle \( y \), then they should not choose \( y \) over \( x \) if both are affordable at a later time. Mathematically, if \( x \) is revealed preferred to \( y \), then \( y \) should not be revealed preferred to \( x \) under the same budget constraints.
Strong Axiom of Revealed Preference (SARP)
The Strong Axiom of Revealed Preference extends WARP by considering chains of choices. If a consumer prefers \( x \) to \( y \), \( y \) to \( z \), and so on, then \( x \) should be preferred to all other bundles in the chain. This consistency ensures that consumer choices are rational over a sequence of decisions.
Examples and Applications
Practical Example
Imagine a consumer with a budget of $100 who can buy either apples at $1 each or oranges at $2 each. If the consumer buys 60 apples and 20 oranges, this choice reveals their preference for this particular combination under the given budget.
Applications in Economics
Revealed Preference theory is used extensively in demand analysis, welfare economics, and market research. It helps economists understand how changes in prices and income affect consumer choices and market demand.
Historical Context
Developed by Paul Samuelson in 1938, the Revealed Preference theory revolutionized consumer theory by providing a method to empirically measure preferences without requiring utility functions. This approach was a significant advancement in economic theory, emphasizing observable behavior over theoretical constructs.
Comparisons with Related Terms
Utility Theory
While Revealed Preference focuses on observed choices, Utility Theory relies on the assumption that consumers derive satisfaction (utility) from goods and services, which can be represented by a utility function. Unlike Revealed Preference, Utility Theory often involves abstract and non-observable constructs.
Indifference Curve Analysis
Indifference Curve Analysis maps out combinations of goods between which a consumer is indifferent. Revealed Preference complements this by providing empirical evidence of which combinations a consumer actually prefers, given their budget constraints.
FAQs
What is the relevance of Revealed Preference in modern economics?
How does Revealed Preference theory handle changes in income and prices?
Can Revealed Preference be applied to non-monetary choices?
References
- Samuelson, P. A. (1938). A Note on the Pure Theory of Consumer’s Behaviour. Econometrica, 5(1), 61-71.
- Varian, H. R. (2006). Intermediate Microeconomics: A Modern Approach. W. W. Norton & Company.
Summary
Revealed Preference offers a powerful tool for understanding consumer behavior through their actual purchasing decisions. By focusing on observable actions under constant income and price conditions, it provides a robust framework for analyzing preferences and making empirical predictions in economics.
